Two Errors That Are Triggering ACA Employer Shared Responsibility Payments from the IRS
Some trends are emerging on what is triggering the IRS to issue Letter 226J notices to organizations.
Since November, the IRS has been sending notices to organizations that failed to comply with ACA’s Employer Mandate (Internal Revenue Code Section 4980H) based on information identified in the annual filing submitted to the IRS for the 2015 tax year. This letter proposes Section 4980H penalties called Employer Shared Responsibility Payments, or ESRPs. It provides the general procedures the IRS used to propose the penalties, and the procedures for the recipient to respond. Private companies, public companies, as well as government entities, are receiving such an ESRP penalty notices. Some organizations are seeing such penalty notices in the millions of dollars.
Among the errors that trigger these Section 4980H penalties, here are two of the most common errors:
Failing to check the Section 4980H Transition Relief Indicator Box.
Your organization could check this box if it is between 50-99 full-time/full-time equivalent employees and meets certain maintenance requirements on workforce size and existing healthcare coverage. If your organization meets these – typically easily shown – requirements, your organization would not be subject to any Section 4980H penalties.
If your organization has 100 or more full time/full time equivalent employees, it could still check this box to apply a 70% instead of 95% threshold for offer compliance, i.e., the percent of full-time employees to whom your organization made an offer of coverage in 2015. If you or your vendor failed to check this box while meeting the 70% threshold, but not the 95% threshold, it will trigger Section 4980H(a) penalties.
Plainly, some vendors who did the 2015 reporting did not understand either of these two forms of transition relief or left it to the client to figure it out and the client did not understand how to invoke the transition relief. The fix for this issue is easy. Inform the IRS that the penalty was incurred because you forgot to check the applicable box. You will need to complete the ESRP Response (Form 14764) along with your signed statement supporting it. (To the extent your organization is seeking the 50-99 full time/full time equivalent transition relief, your organization will want to specify that it met the eligibility requirements in the ESRP Response along with your supporting signed statement.)
Failure to apply the Look-Back Measurement Method properly.
The IRS allows organizations to use two methods to determine if a worker is “full time” under the ACA for reporting purposes: the Monthly Measurement Method and the Look-Back Measurement Method.
Under the Monthly Measurement Method, the employer determines if an employee is a full-time employee on a month-by-month basis by looking at whether the employee has at least 130 hours of service for each month.
Under the Look-Back Measurement Method, an employer may determine the status of an employee as a full-time employee during what is referred to as the stability period, based upon the hours of service of the employee in the preceding period, which is referred to as the measurement period. The Look-Back Measurement Method can be particularly useful for variable-hour, part-time and seasonal employees who are not reasonably expected to average at least 30 hours of service per week, i.e., the definition of “full-time” under the ACA. It also allows for longer “limited non-assessment periods,” which are periods in which the employer need not offer coverage.
The Look-Back Measurement Method requires close monitoring and tracking, and clean, reliable data. Application of this method requires substantial regular attention as information is tracked monthly, as well as a deep understanding of the rules surrounding the Look-Back Measurement Method.
Failure to apply this method properly has resulted in organizations overcounting the number of full-time employees, and thereby overcounting the number of employees to whom the employer must make an offer of coverage. This is the number of employees for whom your organization must show that it made 95% offers of coverage (or 70% threshold for 2015 if you checked the box for Section 4980H Transition Relief).
To challenge the IRS proposed ESRP in order to eliminate or reduce it, your organization will need to review the documentation supporting the 1095-C Schedules to figure out if the reporting was done incorrectly. The biggest challenge is created by the failure to maintain supporting documentation in a centralized location that is easy to access. Unlike the standard ACA reporting process, which potentially gives a client more than a year to gather the supporting documents for the reporting year, once Letter 226J arrives, you typically have 30 days to respond. Even with an extension, you may only get another 30 to 45 days to respond. Letter 226J for the 2015 tax year reporting has been issued two or more years after the end of 2015. This can make the task of gathering supporting documents more challenging if they are not in a centralized location and easily accessible.
How to Prepare
The IRS continues to issue Letter 226Js for the 2015 tax year filings, and will likely begin issuing similar notices for the 2016 tax year sometime this year.
Now is the time to make sure that your organization’s employee information and supporting documentation for the 2015 and 2016 years are organized and easily accessible. And make sure that the needed information and documentation is ready to prepare your annual ACA filing to the IRS for the 2017 tax year. It’s also a good time to review your past ACA compliance process to see how it may be improved to avoid potential errors. Consider consulting a third-party with ACA expertise to assist you in reviewing your compliance process. Many vendors will do an initial review at no cost.
Organizations need to remember that the IRS ACA penalty process is new. While there is a possibility that the IRS may accept your unsubstantiated response as to why your penalty should be reduced or eliminated, the IRS will expect that you have the supporting calculations and documentation underlying the response that the IRS may audit at a future date. Providing incorrect information to the IRS can have severe penalties. You want to have your documentation in hand and easily accessible before responding to the IRS to contest your penalty assessments.
With half the businesses in the U.S. saying they are not confident in their ability to satisfy ACA requirements, and reported ESRPs in the millions of dollars being assessed by the IRS against organizations receiving Letter 226J, the stakes are high. Now is the time to get prepared.
To download an infographic on how to respond to Letter 226J, click here.
For more resources to help you address ACA compliance, visit our free ACA Resource Center by clicking here.
To learn more about ACA compliance in 2021, click here.
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